Spirit Realty Capital Inc (SRC) 2017 Q4 法說會逐字稿

Good morning, and welcome to the Spirit Realty Capital 2017 Fourth Quarter Earnings Conference Call. (Operator Instructions) Please note, this event is being recorded.

I would now like to turn the conference over to [Cara Smith]. Please, go ahead.

Thank you, operator. And thank you, everyone, for joining us today. Presenting on today's call will be President and Chief Executive Officer, Mr. Jackson Hsieh; Chief Financial Officer, Mr. Phil Joseph; and Head of Asset Management, Mr. Ken Heimlich.

Before we get started, I would like to remind everyone that this presentation contains forward-looking statements. Although the company believes these forward-looking statements are based upon reasonable assumptions, they are subject to known and unknown risks and uncertainties that can cause actual results to differ materially from those currently anticipated due to a number of factors. I would refer you to the safe harbor statement in today's earnings release and supplemental information as well as most of our recent filings with the SEC for a detailed discussion of the risk factors relating to these forward-looking statements. This presentation also contains certain non-GAAP measures, reconciliations of non-GAAP financial measures to most directly comparable GAAP measures and they are included in today's release and supplemental information furnished to the SEC under Form 8-K. Both today's earnings release and supplemental information are available on the Investor Relations page of the company's website.

For our prepared remarks, I'm now pleased to introduce Mr. Jackson Hsieh. Jackson?

Good morning, and thank you for joining our fourth quarter and full-year 2017 earnings call. Let me begin by saying that 2017 was a transformational year for Spirit. After a challenging start to the year, we took significant and deliberate steps to reposition the company into a fortress REIT. As we sit here today, Spirit is a much improved company than it was just one year ago. When I joined Spirit in late 2016, one of my first goals was to improve the company's procedures, processes and systems and enhance oversight and portfolio management decision-making. In 2017, the benefits of these efforts became evident. First, from a strategic perspective, we created an in-house research team and developed and implement 2 important tools. We created a dynamic property ranking system, with which we are able to evaluate our entire portfolio on a regular basis as well as compare potential acquisitions and dispositions against our existing asset base. And we created an industry heat map that defines a clear framework for Spirit as we allocate our capital. Second, from an operational perspective, we work to enhance certain key processes and increase our oversight of our portfolio. Most notably, we improved tenant surveillance by bringing all asset servicing functions in-house. Third, we worked to optimize our capital allocation. During 2017, we sold 192 properties for $552 million. Importantly, having identified property cost leakage as a key performance indicator for our team, 105 of those properties were vacant, non-income-producing assets. We also worked to reduce our exposure to Shopko through asset sales and sold 12 revenue-producing Shopko properties for $71 million. As a result of these efforts, we showed marked improvements throughout the year in earnings, occupancy rate, property costs, releasing spreads and lost rent reserves.

From a financial and balance sheet perspective, we also took key steps in 2017 that, we believe, will be beneficial to shareholders over the long term. First, we significantly expanded and improved our disclosures in order to help the market, understand the true underlying value of our portfolio. Second, we were active purchasers of our shares on the open market with $282 million of shares repurchased for the full year. Finally, we raised over $885 million in net cash proceeds from our preferred stock, Master Funding Notes and CMBS transactions. Separately and in concert with these efforts to enhance Spirit as an organization, we worked with our Board and in consultation with outside advisers to evaluate all strategic options to create shareholder value. A key goal was to eliminate certain structural impediments that could not be resolved within a single entity. These structural impediments included the need to isolate our Shopko investment and to better align our asset base with the appropriate capital structures, which will allow for the full maximization of the leverage capabilities of the secured master trust structure.

In August, we announced our path forward, which was our plan to leverage and spin-off Master Trust A and our Shopko assets into a separate entity called Spirit Master Trust or SMTA. Since then, we have made substantial strides towards completing this transaction. In late 2017, we confidentially filed our Form-10 with the SEC. Since then, we completed ABS financing and remarketing of our notes for Master Trust A and completed our CMBS transaction. In addition, we funded $35 million into an existing Shopko secured credit facility and concurrently amended our lease with Shopko by removing terms that could impact our ability to monetize value for these assets including eliminating a minimum rent threshold and added approvals to meet potential SEC reporting requirements. Importantly, we have outperformed on nearly every metric we laid out at the time we announced the path forward including pro forma leverage, timing and amount of capital raised. We expect to publicly file our Form-10 shortly after we file our 10-K for 2017. We remain on track to complete the spinoff by the second quarter 2018, and as I stated in our Path Forward III call, the completion of this transaction will have a profound positive impact on both companies. With this separation, New Spirit will have significantly improved credit metrics and optimized portfolio, and most importantly, plenty of dry powder to grow, hopefully, resulting in a competitive cost for capital. I'm proud of the entire team at Spirit and thank them for their hard work and dedication through this process.

Now turning to our quarterly results. For the fourth quarter, we reported $0.21 of AFFO per share and $0.85 of AFFO per share for the full year 2017 including severance charges. As we disclosed on our Path Forward III call in January, we were, again, a net seller of assets in the fourth quarter. These sold assets track our industry heat map in the general merchandise, drugstore, casual dining and grocery industries. We sold approximately $145 million of assets in the fourth quarter, which brought our full-year total to $552 million. Nine of our fourth quarter dispositions were vacant properties, bringing our full-year total to 105 vacant properties sold for $154 million. We expect to benefit from both reduced property cost leakage and redeployment of this capital into higher yielding investments.

Turning briefly to our balance sheet. During 2017, we repurchased 35.8 million shares at a weighted average share price of $7.88 for a total of $282 million. We ended the year at 6.3x adjusted debt to annualized adjusted EBITDA as compared to 6.5x in Q3. And pro forma post-spin leverage is expected to be 4.5x adjusted debt to annualized adjusted EBITDA. As of December 31, our portfolio, which is comprised of single tenant, operationally critical real estate properties in 49 states was 99.2% occupied and had an average remaining lease term of 10 years. 45% of our contractual rental revenues were derived from master leases and 89.2% of our leases have built-in rental increases. Approximately 95% of our tenants provide us financial information and our weighted average unit level 4-walled rent coverage for our top-10 tenants was 2.1x. The reduction from Q3's 2.5 coverage was related to Regal theaters (sic) [Cinemas] replacing Albertsons in the top-10. The 4-walled coverage for Q4 using last quarter's top-10 tenants will be 2.4x. During the quarter, Spirit renewed 15 of 16 of our expiring leases and our revenue recapture rate was 98.5%. For the full year, we renewed 41 of 47 leases and recaptured 101.1% of expiring rent with $1.2 million in additional capital expenditures.

Finally, we have provided incremental information on Shopko, as recently as today, on our Investor Relations website, and are providing the following update on their third fiscal quarter results. Spirit-owned Shopko stores' comparable sales for Q3 2017 versus the same period in 2016 decreased 2.6%. And trailing 12 months comparable sales decreased 2.9% with unit level 4-walled coverage of 2.5x. During the fourth quarter, we sold 1 revenue-producing Shopko store for $6.9 million at a 7.85% cap rate and 1 vacant former Shopko store. Through year-end, we have sold 12 operating Shopko stores for $71.4 million, an average cap rate of 7.7% and 14 vacant Shopko stores for $9.6 million. We have reduced our Shopko rent concentration to 7.7% of Spirit's total contractual rent. Overall, the fourth quarter was another consistent quarter from operational perspective and our results are demonstrative of the strength and stability of our diversified portfolio of freestanding, triple-net real estate.

Before I turn the call over to Phil, I'd like to say a few words related to the press release and 8-K that were filed today outlining the upcoming departure of 2 of our senior executives. Phil Joseph and Spirit have mutually agreed not to renew Phil's employment contract, which expires on April 20, 2018. Phil will stay on as CFO through the end of his employment contract and the company has engaged a search firm to find his replacement. Boyd Messmann will be leaving Spirit to pursue other opportunities. We will be merging the efforts of our direct sale-leaseback effort, led by Daniel Rosenberg and our acquisitions team in an effort to grow and improve business with our existing tenant base. I thank Phil and Boyd, for their contributions to improving Spirit Realty Capital and wish them the very best in their future endeavors. I'll now turn the call over to Phil. Phil?

Thanks, Jackson. As previously mentioned, we reported AFFO of $0.21 per diluted share for the fourth quarter of 2017, which was in line with our prior year fourth quarter. Disciplined capital allocation most notably meaningful share repurchases in addition to lower fee income largely drove our performance quarter-over-quarter. For fiscal year 2017, we reported AFFO per share of $0.85, which includes cash severance charges of $0.01 per share. From a capital allocation perspective, we have reduced our weighted average share count by approximately 6% as a result of our open market share repurchases. During 2017, we repurchased approximately $282 million of stock at a weighted average price of $7.88 including 7 million shares during the fourth quarter. Our accretive share repurchases were completed at a -- in a leverage-neutral manner and notable dividend savings will increase our cash available for investment. On the portfolio management front, during the year, we have been a net disposer of assets to the order of $228 million including $154 million of vacant assets. Our portfolio capital recycling activities have been accretive to earnings having acquired $323 million of assets at a weighted average cap rate of 7.7% and selling $398 million of income-producing assets at a weighted average cap rate of 7.1%. Furthermore, our vacant property dispositions have reduced property cost leakage. Our post-spin balance sheet will benefit from the recent ABS and CMBS financings that raised net cash proceeds of approximately $710 million. Post spin, our financial standing will notably improve with pro forma debt-to-EBITDA at approximately 4.5x. Unencumbered assets representing approximately 70% -- 75% of gross real estate assets and secured leverage at approximately 10% of gross assets. These metrics should notably enhance our access to and cost of capital as well as our investment-grade profile. Total revenues for the fourth quarter of 2017 were $165.3 million compared to $173.4 million in the fourth quarter of 2016. Net disposition activity and lower fee-related income contributed to the decline in revenues. Same-store rent growth for the quarter, when compared to the prior-year fourth quarter was up 0.5%. This increase is largely driven by organic rent growth in the portfolio, which was slightly offset by underperforming assets in our plan to transition to SG&A. Excluding assets transitioning to SMTA, our reported same-store rent growth would have been 2%. Total expenses excluding costs associated with the spin-off transaction in the current year and headquarter relocation costs in the prior-year period decreased to $147.9 million in the current year fourth quarter from $184.8 million in the same period of 2016. Lower noncash impairments largely drove the reduction in the operating expenses. With respect to run rate G&A, it represented approximately 7% of total revenues for the quarter. Our property cost leakage was flat compared to the prior-year period while elevated compared to the third quarter 2017. We continue to target property cost leakage of 2% of total revenues on a go-forward basis. Cash interest expense was relatively unchanged compared to the prior fourth quarter despite the repayment of $137 million of secured debt during the current quarter, largely due to higher average borrowings under our corporate bank facilities during Q4 2017 as well as our $674 million ABS issuance in December. During fiscal year 2017, we extinguished approximately $238 million of secured debt with a weighted average coupon of 5.5% and as of today, we only have $125 million of non-defaulted bullet debt maturities through the end of 2018. In addition, subsequent to year-end, we have resolved $34 million of defaulted loans via deed in lieu transactions with lenders. As to our corporate liquidity, we currently have $1.2 billion available under our corporate bank facilities and $112 million of cash balances including $102 million in our Master Trust Notes release accounts. In terms of our financial standing, we achieved our year-end leverage target of 6.3x, our reported fixed charge coverage stood at 3.3x and our $4.7 billion unencumbered asset base continues to represent approximately 60% of our gross real estate investments. As mentioned previously, post-spin, our pro forma debt-to-EBITDA will be approximately 4.5x. Looking forward to our 2018 year-end leverage target, we would expect debt-to-EBITDA to be at or below 5.5x. During the quarter, we declared dividends to common stockholders of approximately $81 million dollars, which represented an AFFO payout ratio of 84% compared to $87 million representing an AFFO payout ratio of 85% in the comparable period a year ago. In conclusion, Spirit is well positioned for accretive growth post spin now that we have closed meaningful financings in connection with the spin transaction. Our balance sheet strength and [moderate] debt maturity profile will enable us to be strategic on the capital allocation front. As I previously noted, our year-end leverage target is to be at or below 5.5x. While we are mindful of our current cost of capital, we will continue to allocate capital in a prudent fashion. For SMTA in the near term, that will mean that we will use Master Trust Notes release account cash proceeds to acquire replacement assets to enhance operating cash flow for its stakeholders. Currently, there is $80 million in our master trust 2014 release accounts that will be invested in new acquisitions at a targeted weighted average cap rate of 7%. For Spirit, the illustrative benefits related to repurchasing shares or acquiring assets is largely dependent on the timing of capital allocation activities. At this time, we anticipate providing earnings guidance for Spirit and SMTA in connection with our first quarter earnings announcement if not sooner. I am proud of the accomplishments the team has made during the 3 years that I've been here. Before I accepted this position as a condition, I wanted to make sure the company was in line with my primary goals of improving Spirit's capital structure, access to and cost of capital as well as its financial disclosure. Spirit's now investment grade has much improved access to capital and its financial disclosure is extensive and transparent. Along the way, I was able to build a best-in-class finance, FP&A, tax and accounting team that will ensure ongoing business continuity.

I will now turn the call back over to Jackson.

Thanks, Phil. And we would like to open it up for any questions. So operator?

(Operator Instructions) The first question comes from David Corak with B. Riley FBR.

In terms of your refined strategy to sell Shopko's that you mentioned a month ago, as it pertains to kind of the seller financing and the spreading the wealth a bit now and with the number of brokers and commission structure. I realize, it's only been 1 month or so, but what's the feedback been from the market? Has this facilitated the process at all?

David, it's Jackson. I'm going to let Ken answer that question. Go ahead, Ken.

Yes, so we are in the early stages of that strategy, but early indications are good. It does take new brokers a little bit of time to get up and running. But thus far, we're pretty happy with the interest that we're receiving based on the new relationship with those brokers.

Okay, fair enough. And then, just one for you, Jackson. Do you expect that the spin would occur before kind of the executive departures? Or will you have backfilled the CFO role by then? Or you -- could you conceivably be transacting the spin without a CFO?

Well. Let me just go forward. I think, to answer your question, we have -- first of all, we are well down the road with the Spirit's CFO replacement and we're equally well down the road with the CEO of SMTA and the CFO of SMTA as well and SMTA Board. So we've got a number of different processes moving forward and I would expect them all to be in their seats at the time of the spin.

The next question comes from Vincent Chao with Deutsche Bank.

I know, it's probably a little bit sensitive topic, but just curious if there's any other color that can be provided in terms of the departures. And Phil, you mentioned some of the accomplishments that you've achieved as the CFO. So I don't know if that's implying that you feel like you've, kind of, done and accomplished what you want, but just given the timing of the spin, it does seem a little bit odd. So just curious, if there's anything else you could potentially provide here?

I'm sure, I'll take it. Look, if you can't recall, I took over the reins as CEO in May, and I was very clear, I was trying to improve processes, the organization. And I think, in terms of Phil and myself, we did have a conversation back in November, because we knew his contract was coming up, and we hadn't made a determination at that point, but I felt like given where we are, where we want to go, it made sense for both of us to kind of pursue other directions. I can tell you that we, obviously, didn't want to try to do this while we were doing all of the financings and the work on the Form-10, but if you were going to make this change, if you think about it, given the timing of his contract, where we are in the process, if you are going to make a change, this is about the right time to do it, before we actually execute on the actual spin itself. The one other thing that I would add to is, we have a very deep bench, our Chief Accounting Officer, our accounting team, tax, I mean, we've run through as fast as I've seen a Form-10 spin-off get put together, in terms of tax analysis, part of our accounting work on the Form-10. It's not just 1 individual, it's really a team and we've got a very strong team there.

Yes, I mean, Vin, it's Phil, I would echo that. I mean -- as you know, when I first got here, their -- the capital structure was much different than what it was today. There's about $1.5 billion of debt maturing between when I got there through the end of 2017. We've completely recapitalized our balance sheet. We refinanced a ton of secured debt maturities, increased our unencumbered assets by over $2 billion, got to an investment-grade standing, improved our access in the cost of the capital and derisked the balance sheet. Our financial disclosure was kind of nonexistent when I joined, and we've continually just enhanced it over time. And I think, it's best-in-class financial disclosure. And then I totally agree with Jackson. I mean, in terms of the team that we have here at Spirit, I mean, I do think, we have a best-in-class finance, accounting, tax and FP&A team. And I do think, the go-forward team is very well positioned.

And then I know -- you could look at this as, sort of, glass half full or half empty, but I would tell you that if you look at the people, Ken was hired last year as Head of our Asset Management team; Dave, Head of Research; Bill, we moved him to Head of Credit; Danny has been with the company for 10 -- 11 years now, is moving from his direct sale-leaseback efforts to really handle the acquisition team. And as I said, CFO, CEO and CFO of SMTA and our new Board for SMTA, those will all be -- we are well down the road with all those individuals and expect to have them in the seats very, very shortly.

Okay. Maybe just a different topic. Just looking at the total rent recapture rate, over the last couple of quarters, it has been coming down. Obviously, it's difficult to retail market. But I'm just curious, If you feel like that has stabilized at this point and could potentially go higher going forward? Or do you think -- assume that 80 percent-ish level is about where we're going to be for some time?

Are you referring to the -- on the renewals?

On -- no, the total rent recapture that you disclosed on the supplemental. I don't have the page in front of me, but it's about 79% for the quarter.

Okay. Yes, I mean, I think, it's sort of -- when you look at that, obviously, it depends on if you have tenants going vacant. I mean I would say that, sort of, the headline for me as I look at it and I think about what was happening in the first quarter last year, where we are today, I think it's really largely behind us. The last small portfolio of assets that we're moving into SMTA, we refer to them as, sort of, the workout portfolio, such as learning for instance, is in that portfolio. They're 3 of them. They're ranked #82 in our top-100 property list, 0.3% % of rents. They filed bankruptcy last -- last month. So it's literally like 4 tenants that are moving in and I think it's going to be largely behind us and I think you'll see much more steady renewal rates and operations out of Spirit going forward. More similar to our peers.

The next question comes from Daniel Santos with Sandler O'Neill.

Just going back to the C-Suite transition, I'm just wondering once you have those 3 executives that you mentioned in place, should we expect that this transition period should be over?

Yes.

Or are there more team members that you are looking to bring them on board?

No that's it. I mean, there's some minor -- I could tell you just from a processes standpoint, I mean, it's all about dual company readiness right now. Every process that we're running internally, whether it's credit committee, disposition committee, talking about any -- our senior management team meetings, everything is sort of done in the way of thinking about it as 2 companies at this point. So we have -- we'll be completed with this last series of changes.

Got it. And then does void impact affect any deals that are in process? And how should we be thinking about acquisitions and dispositions in the year?

Well, I mean, first of all, Dan Rosenberg has been running our direct sale-leaseback team since last year, middle of last year. And as a goal, I could tell you that we want to do more business with our existing tenant base. We have over 400 tenants and a number of them are largely in the right area in the heat map that we need to expand in. That's not to mean that we won't buy assets from brokers, that's always kind of part of the flow as well. But if you look at what we acquired in 2017 -- you know, in 2017 we had $144 million group of acquisitions in the first quarter, $83 million in the second, $62 million in the third and 0 in the fourth. So it did roll-off, but it's rolling right back up again. And if you look at the 2017 acquisition class and we'll show you this when we get to the city, we'll have a heat map that shows where these things actually have a fit in our heat map, but the 3 Home Depots, the new FedEx building we bought in Michigan, the distribution center, all the entertainment assets, I'd say, about half of those assets were bought through our existing tenant base. So I don't think we're going to see really any disruption at all, to answer your question.

The next question comes from Vikram Malhotra with Morgan Stanley.

This is Kevin on for Vikram. I just had a quick question in terms of the rent coverage. It looks like it dropped a little bit this quarter, so wondering if you can give any additional color around that?

Yes, so the rent coverage, once again, it goes -- we refer to the top-10. I mean, we -- first of all, to answer your question, Shopko rent coverage is, as you know, was basically on the margin actually improved from third quarter to fourth quarter -- third quarter to fourth quarter. We had some softness in our Church's, Cajun portfolio. There was some weakness in sales there and that's what, sort of, had some of the pushdown. AMC, Carmike's. AMC is in the process of integrating the Carmike portfolio. We're in the process of doing blend and extends and putting capital into those assets right now. So we saw some weakness on the coverage there. But the big impact was we sold the Albertsons property up in Renton and that sort of made them drop out of the top-10, while Albertsons' 4-walled coverage is over 6x. So moving Regal back up, on the margin, had a little bit of numerical impact to it. I would say overall for the portfolio we have seen some reduction in coverage; I would just tell you. I think part of that is just general, sort of, what's happening in the business, but it's not a trend that I'm really concerned about at this point. I think we have a very durable service-oriented retail portfolio.

Okay and just one quick question. In terms of the tenant watch list, are there any, I guess, any issues or any new tenants that are on your list or -- that you're keeping your eye on?

In the first quarter of last year, we obviously had a lot of things that were creating a lot of headaches. And I can tell you where we are today, we just really don't have any. I mean, we're moving the things that -- handful of small things that are moving over into SMTA are the, sort of, last things basically. In that first quarter that was identified last year that was sort of pushing on us.

Okay, and then just one last one. Any update on the spin, just anything, you think, we should now since the Path Forward III.

No, I mean -- I think we -- obviously, I know people who want us to put out guidance probably, but, I mean, we -- we're on track. You'll see the public live filing really shortly. I would hope, at the end of next week, but it's going to be the following, no later. So we will get the live filing out. You're not going to see the new board members or executives of SMTA in place, but in subsequent filings, shortly, you will see them. And I think that it'll make more sense to us to give guidance for New Spirit once those numbers are out. But you can do the math, 4.5x is going up to 5.5x, it's -- you can -- depending if we're buying assets or buyback stock in New Spirit, it's actually quite accretive. So we're not really concerned, but it's just from a timing standpoint, we really didn't want to get ahead of ourselves, but I'm trying to give guidance.

The next question comes from Ki Bin Kim with SunTrust.

Can we talk about the dividend pro forma for the company? Any chance of you guys cutting the dividend after the spin is done to preserve some capital, which might be the right move?

Yes, after the spin is done, we haven't come back with dividend policies for both companies yet, but we will -- we're still evaluating it. So I don't really want to get ahead of it yet. But I can tell you that for sure at SMTA, it's going to have a very high payout ratio. I would just, kind of, tell you that.

Yes, I can see that, but I am talking about the New Spirit, because I mean if you want to operate and retain cash flow, I could imagine an effective dividend cut, that's why I ask. Okay, so the other interesting thing is that it seems like a lot of your releases have a CPI component to it. Can you just talk a little bit more about that? What the mechanics are? Is that like annual basis or quarterly or is it longer term? And given the, kind of, early signs of some inflation, in the U.S., any kind of meaningful impact to you guys?

Yes, we -- the -- out of all the leases that have escalators, which is about 89% of the portfolio, you can see about 37% of those are CPI-related and they typically have some type of floor in them. But yes, so we'll get a boost as those come on, some are annual, some are every 3 years. But the majority that we -- of our escalators are in the fixed category, some annual, some 10% every 5 years.

Okay, so, I guess, maybe, a little too early to tell what the financial impact could be?

Well, I think, what you're, sort of, looking for is, they're going to be in different buckets, right? So in New Spirit about 20% in the portfolio will be CPI-related, 15% flat, 65% contractual bumps. And then at SMTA, you'll have 35% contractual fixed, 61% CPI-related and 4% flat. So the take away for me is, SMTA is going to have much more, kind of, upside fluctuation in a rising CPI environment, whereas New Spirit, obviously, will have more just city contractual bumps. And that's partly a function of, if you think about the assets in New Spirit, we talked about it a little bit, our top 5 tenants will be, Walgreen's, Church's, Couche-Tard, Home Depot and CVS. So it's kind of got a more investment-grade orientation just in the top 5. And so as you think about how CPI impacts the portfolios, that would -- we don't have a model yet for it to kind of give you, but directionally, I think you know where most of the CPI portfolio will be in terms of SMTA.

Okay, and lastly, I know, there's always differences in methodology for same-store, but if I actually add back -- if I look at your definition, it seems like the ones that were relet may not be in the same-store calculation for contractual rent increases of that 0.5% you guys posted. But if you add back some other ones that got relet, it looks like it might have made a decent impact. What does that same-store NOI look like with the reletting?

From a same-store perspective, as it relates to the same-store pool, I mean, how we laid out in our disclosure, is it includes those leases excluding multi-tenants, excluding vacant properties. And their relet impact of those tenancies should be impacted in the overall same-store pool, the 0.5% that we disclosed. One of the things that I wanted to call out as well was that there were certain tenancies that were driving same-store rent lower year-over-year and tenancies that are moving to SMTA. And if you exclude the impact of those, our same-store would've actually been 2%.

In New Spirit.

In New Spirit, yes.

The next question comes from Haendel St. Juste with Mizuho.

I was hoping you could expand a little bit on your comments about the leakage in the assets you're -- I think, you're selling. Is it something that you are referring to the assets being empty in terms of leakage or is it something perhaps in the operations. Just trying to understand how much of an opportunity that could be there, and over what time frame perhaps you can achieve some of those implied efficiencies?

So, I mean, I guess, we're talking about property cost leakage. So, this last quarter, when we, kind of, look at the property cost leakage, third quarter was really where we want to be operating from a property cost leakage perspective, and I'm saying, specifically, go-forward Spirit. We're targeting about 2% of revenues from our property cost leakage perspective. When you look at the fourth quarter, there were just certain issues that came up with respect to, obviously, credit issues and specifically tenancies that are transitioning to SMTA. We had some incremental vacant asset leakage in Gander, I'll point out, in particular, was a part of that. And then we had a onetime CAM rec expense with respect to certain tenancies. That's not a go-forward basis. So I think go-forward for Spirit 2% of revenues is a really good run rate number.

Got it. Another question perhaps on deal flow looking a bit here at Danny's background seems to be more of a sale-leaseback guy. I'm curious if we could -- should expect to see those types of deals accelerate as we move forward under his leadership there? And what potentially that implies for, I guess, the types of deals you'll be looking at near term?

Look, I mean, Danny has been -- he is -- firstly, he has been doing it very successfully for the past -- since the beginning of -- early part of last year. But what I tasked him to do back in early 2016 was, look, we have a portfolio of over 400 tenants, we're not going to want to do business with all of them necessarily or repeat. But there are a very good number of tenants that we wanted to actually do more. And so he basically started to coordinate that effort, working with our existing tenants, trying to do things more directly, i.e. without a broker, and we really started to get good traction there and I don't think there's as much focus on that, organizationally here, and I can just tell you from what early returns we're seeing, it's -- the benefits are when you buy properties with existing tenants, you first of all get them on new release form, number one. Number two, you can actually put them into existing master leases where we have ownership. So that's a benefit. Three is, like you said, we're talking to our tenants on a much more frequent basis today than we were 1 year ago. And you just learn things where there's opportunities, where there's things that we can help one another, just like in Shopko. So you'll see that more out of our effort going forward. And I think you get better pricing, you get better terms and conditions, you have much more control over your deal flow. And it doesn't say that we won't buy Home Depots on the open market. We bought 3 last year. We bought a brand-new FedEx distribution center, in Michigan, which is a great property. So we'll continue to do and there's a team that focuses on that, that Danny is going to take on, but we look at this as a real opportunity to give him some runway to grow. And it also gives people in our asset management team an opportunity. There is going to be some promotions in that group where people will take on more responsibility under Ken. So it's just part of the natural evolution of -- as these organizations develop.

Appreciate that. One more and then I'll jump back in the queue. You mentioned the coverage for your top-10 tenants is 2.1x. What's the coverage for the remaining portfolio? What percentage of rent is that as well?

So, I mean, in terms of percentage about 50% of our tenants, overall, today, give us reporting units about 51%. We're running at about 2.7x as a portfolio. If you exclude manufacturing assets out of that number, it drops down to 2.6x, and that's for the 51%. When we actually split the company in terms of that 51%, about -- it's -- the large majority will actually of those reporting units move into SMTA, so just directionally. And once again, the drop in coverage is not related to Shopko, it's, sort of, not -- it's sort of isolated, some go up, some go down. But we had, obviously Cajun, AMC had a -- sort of, had a negative impact this past quarter.

Okay. Any early conversations Albertsons' Rite Aid, any early color or thoughts you can provide on that front?

Well, look, I think, we own 23 Rite Aids and 22 Albertsons right now. I think it makes a lot of sense for Rite Aid if you think about what Walgreens and CVS are doing in terms of providing more service and health in the box and trying to get away from retail. If you think about Rite Aid, they have great balance sheet, but less coverage. So for them to, kind of, go to a service model to compete against CVS and Walgreens, I think, that's like a tough -- that's long putt, right? So them teaming up with Albertsons to move is, kind of, a very interesting idea, because we see that, for instance in Shopko. Shopko's pharmacy and optical within what they do and their general merchandising box delivers significant flow-through EBITDA, and so I'm sure Albertsons -- I think, for Rite Aid to compete, it's, kind of, a very interesting idea. Obviously, they're both nation -- Albertsons has a nationwide portfolio and, I think, there'll be very interesting opportunities as they, sort of, think about it. So I think, it's very positive relative to Rite Aid standing alone and trying to compete head-to-head with CVS and Walgreens.

Appreciate that. Jack, actually, I apologize, I just got an e-mail in from an investor and so if it's okay with you, I just want to read the question for you. We are trying to understand how stable SpinCo and SpinCo's payments to RemainCo are and are struggling a bit. Can you help with a few structural questions? One, is the run rate annualize amortization for the SpinCo master trust around $44 million and the annual amortization on the Academy CMBS around $3 million? And then secondly, if the Shopko rent goes away, is it correct that you would have to cut the dividends on SpinCo to 0 and only be able to pay out 1/3 of preferred dividend back to Spirit RemainCo?

First of all, that's a lot of stuff. So I would just add the amortization on the $40 million is higher. The run rate is more like $33 million on the MTA assets. The -- and as it relates to, like, scenarios on -- look, we're just -- we won't speculate. We're designing a structure as it relates to the preferred investment that we have and the management contract to kind of work on sync with the assets that are sitting in SMTA.

The next question comes from Wes Golladay with RBC Capital Markets.

You guys are doing a pretty good job at looking to drive down the cost of capital by lowering the debt levels, cleaning up the portfolio. To me, the next leg down for driving down the cost of capital appears to be demonstrating value creation through external growth. I wonder if you agree with that and then if so, how do you view weighing improving out your acquisition platform or new acquisitions this year, versus investing in existing tenants or in the portfolio via buyback?

Well, look, I think you hit around the head. You make money, in my opinion, on things you buy. And I think if you think about where we were deploying capital in the third quarter or fourth quarter of 2016, our stock was very, very undervalued in our opinion. As we move forward, like I said, I think, that buying with tenants that we know, we like, we understand, we can do it directly, I think you create more value doing that. I think the cap rates will be better. We've got ability to, kind of, control our pipeline. And so we want to -- we really want to grow our asset base in New Spirit. And over at SMTA, they will grow too, but it's more of a recycling of Shopko assets into similar kind of assets, that we're talking about, that would go into Spirit. So it's -- they're both -- as you said, you actually make money on the things you buy, and we're very clearly -- as opposed to things you sell. So we're very sensitive to that.

The next question comes from John Massocca with Ladenburg Thalmann.

So you guys, kind of, mentioned that you felt your stock was undervalued. How do you view the buyback program today? And maybe, kind of, more particularly, is there any reason you couldn't utilize the program between now and the completion of the spin?

Well, to answer your question, we remember, like, when I laid out our path forward back in August, 6.3x debt-to-EBITDA at year-end, that was like a real target. I mean, I didn't just say it. And so if you, sort of, look at quarter-to-quarter, what we bought, what we sold, how much stock we bought back, it's, sort of, all added up to 6.3x, not by accident. As we think about buying back stock today, as Phil said, the priority is to actually get the master funding cash in those lease accounts deployed. To have it sit there, we can't take it out, there's penalties if we wait too long, you got to -- they're designed to be used. So that takes, kind of, first priority. And if you think about buyback like now versus later, I think, you actually get more impact potentially in buying back post-spin in Spirit versus if we buyback today, 80% of the company benefits from the buyback and 20% goes to SMTA. So our sense is this that we are focused on right now adding assets into the combined companies and we will still look at buyback. Obviously, it's -- I can't tell you what our cost of capital is, obviously, for New Spirit, but obviously, that's going to be an important benchmark for us. But I don't suspect that we will be buying back shares in the first quarter. It's really going to be more top line assets right now, as I said, focusing on the release account cash in -- particularly, in master trust 2014.

But if you felt your cost -- it's obviously, theoretical. We don't know what the cost of capital is going to be, but if you felt your cost of capital -- or you felt there was a better investment opportunity to buy back your shares in post-spin Spirit, you would still be willing to do that as opposed to, let's say, ramp acquisitions...

No cash -- yes, I mean, look, you buy back shares, obviously, it's readily accretive for earnings, it saves some dividends, and we're not just buying for buying. As I said earlier, you're buying to -- the things you buy is where you generate returns. We're sensitive to that. So to buy things that are -- if our stock is at a better value then we can deploy assets, well, that's really the -- the math is the math on that. So I'm hopeful that we will have a competitive cost of capital, but -- and we're doing all the things that we talked about to get ready to do that, but as I said, we can't control that necessarily. But what we can do is we can make real conscious decisions on getting good returns for our capital.

Understood. It makes sense. And then, kind of, switching gears a little bit, you mentioned that, kind of, excluding assets that are transitioning to SMTA assets' NOI growth would have been, kind of, around 2%. I mean, as we look at it on, kind of, on an industry basis, is there any industry -- on Page 17 of the sub -- where that would lead to a big jump in assets NOI growth? Or would it, kind of, be an across-the-board increase in performance?

Let me make sure I understand your question, John. So you're talking about, like, same-store or...

Same-store.

Yes, yes, same-store like a...

Yes. So, look, same-store -- it's -- same-store is tricky to get general trends, to be honest with you, like change in zoning has a big impact in that segment. This -- they were, sort of, declining in the fourth quarter performance-wise. They, obviously, filed bankruptcy last month. In the entertainment area, we have 1 go-cart operator, small asset that's making trouble. It was same asset back in the first quarter 2016. So it's not new to us. On the health side, there's a small portfolio of NeighborHealth assets that are moving over and there's like a car dealer. So these are very small isolated things, but they were things that sort of -- that paint a much dire picture than really is the fact -- the case. Very small portfolio.

Right. And the other thing I'll add in, Ken, kind of, touched on this as well is that, obviously, there's periodic versus annual escalators that are going to come through at any one point in time. And then as it relates to percentage rent, we don't recognize percentage rent on an accrual basis. We do recognize it on a cash basis in same-store. That also had a minor impact to the downside during the quarter-over-quarter. So there's a whole bunch of different factors that come into play in same-store just on a run-rate basis.

Understood. And then, kind of, with the -- theater operators kind of performed maybe best amongst your segments on a same-store NOI growth basis. Is some of that tied to, I know you just had a theater operator that you are having trouble with around this time last year. Is that just weaker comps or was there something specific that drove out performance in that segment?

No, on that -- that was really just a theater development coming online compared to the prior period. So that was the main driver there.

This concludes the question-and-answer session. I would like to turn the conference back over to Jackson Hsieh, for any closing marks.

Okay. Thank you very much. Well, in closing, and this really goes out to our public -- equity investors, our new and existing MTA bondholders, and our unsecured investors and all of our other relationships with vendors. We really appreciate your continued support, interest and patience in our effort to improve our people processes, portfolio and balance sheet. As your new CEO, since the second quarter of 2016, I've really tried to deliver on what we've communicated to you. If you think about it, there were a lot of unanswered questions back in 2016. Today, we have the answers. So we're really positioned to focus on driving growth in New Spirit and SMTA in 2018 and beyond. So, once again, I want to thank you, again. Bye-bye.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.